There Are Reasons To Feel Uneasy About Zhejiang Zhengguang Industrial's (SZSE:301092) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Zhejiang Zhengguang Industrial (SZSE:301092) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Zhejiang Zhengguang Industrial:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.046 = CN¥86m ÷ (CN¥2.0b - CN¥167m) (Based on the trailing twelve months to March 2024).

Therefore, Zhejiang Zhengguang Industrial has an ROCE of 4.6%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.5%.

Check out our latest analysis for Zhejiang Zhengguang Industrial

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Zhejiang Zhengguang Industrial has performed in the past in other metrics, you can view this free graph of Zhejiang Zhengguang Industrial's past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

In terms of Zhejiang Zhengguang Industrial's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 24%, but since then they've fallen to 4.6%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Zhejiang Zhengguang Industrial has done well to pay down its current liabilities to 8.2% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Zhejiang Zhengguang Industrial's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Zhejiang Zhengguang Industrial have fallen, meanwhile the business is employing more capital than it was five years ago. It should come as no surprise then that the stock has fallen 10% over the last year, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Zhejiang Zhengguang Industrial (of which 2 are significant!) that you should know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.